Salesforce: The Empire Strikes Back

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EmpireBenioff

Well that is probably overstating it but the Salesforce is out of balance and seeking to change their fate (yes, this blog will be full of dodgy Star Wars references and feel free to play a drinking game of taking a shot for every reference you recognise). Last month I reviewed the end of year results for Salesforce and suggested it was the end of hope. But, perhaps, there is A New Hope (see what I did there?) for Salesforce.

We have not entered a world off of our existing star maps, Salesforce is still selling 10 credit notes for 9 credits but the financial signals are mixed. Let us begin the process of gathering intelligence on The Empire.

Intercepting Quarterly Transmissions

Why LinkedIn Could Help Microsoft Beat Salesforce in the CRM Space

An interesting piece speaking at the CRM industry as a whole and the relative market share of the players within it.

Using Salesforce to access SAP? Pour yourself a stiff drink

An grey area which, in truth, affects most enterprise software architectures where integration between systems is required. The results of these cases have the potential for big impacts in the industry. Ironically, in raising the licence cost of integration, SAP have effectively lowered the barrier of exit for their product, giving incentive for companies to switch to a more integration-friendly system.

Salesforce Goes Net Zero Decades Early, Strives for 100% Renewable Energy

Reading the article there seems to be a bit of double-speak about how this was achieved, or is being achieved, but with data centers being as energy intensive as they are, Salesforce’s focus on doing the right thing is admirable.

The (Stock) Power of the Dark Side

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Salesforce’s stock price for the three months up until the end of May. Nothing too interesting here with the price increasing from the low eighties to the high eighties. The quarterly announcement came out on May 18 with the peak at the end of the graph reflecting a positive response from the stock market.

The Manipulations of the Emperor (Insider Trades)

2017 Q1

2017 Q2

2017 Q3

2017 Q4

2018 Q1

Insider Sales

4.80%

4.80%

4.70%

4.70%

4.60%

Institutional Sales

5.75%

5.68%

5.58%

5.49%

5.45%

Clearly the percentage of sales is decreasing slowly over time but, to be clear, there are zero purchases by the insiders. In the last six months, executives at Salesforce have sold over two million shares but have purchased zero. Why would executives who talk endlessly about how their business is going from strength to strength be systematically selling out?

If you are considering buying Salesforce shares on the back of Benioff’s moon-sized personality, while he is charming to the last, ask yourself, who’s the more foolish? The fool or the fool who follows him?

The Progress of The Empire (Numbers of Note)

The Mixed Signals of Revenue and Cost

Let us look at the quarterly growth of revenues and costs. This is the imbalance I referred to at the start of this Lucas love-in.

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In any business we want revenue growth to outpace cost growth, so our margins improve. This quarter this has happened. Revenue growth is at 4% (although the lowest in two years) while cost growth is at 3%. Sure enough margins have improved going from –2.2% to –0.3% margin (yes, Salesforce continues to make a loss).

There is another pattern here which is difficult to explain. For the most recent three years (12 quarters in total), cost growth alternates between increasing and decreasing every quarter. In other words, cost growth slows in the first and third quarters and accelerates in the second and fourth, up, down, up, down etc. Revenue fluctuations are not correlated, which also surprises me.

Now let us consider the year on year graph.

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While the graph is smoother and the periods of margin improvement and erosion can be easily seen (margin growth up to 2011 Q1, deterioration between 2011 Q1 and 2015 Q1, growth until 2017 Q1 and now deterioration again), the counter signal comes from where the graph ends. While the quarter on quarter growth has revenue above costs, not only does the yearly graph have it the other way around, but the gap is widening. In fact it is the widest it has been in three years, since the last period of ‘dark times’.

Does this mean the long term margin prospect is poor but the short term good? What will happen to bring balance to the Salesforce? Let us look elsewhere for clues.

“Your Eyes Can Deceive You; Don’t Trust Them” (GAAP vs Non-GAAP)

Moving to the transcript, it is still all about Non-GAAP results with seven Non-GAAP mentions and zero GAAP results.

SevenSith

Interestingly, the quarterly results from the Salesforce page has this quote from our favorite middle-aged white guy in a black suit, Marc Benioff.

“With our outstanding first quarter results, we are thrilled to be raising our fiscal 2018 revenue guidance by $100 million and raising our GAAP and non-GAAP earnings per share expectations for the year”

Why is he mentioning “GAAP”? Well, it was a long time ago in a quarterly report far, far away that Salesforce could predict an actual yearly profit (six years, actually). However, for the next financial year, Marc is predicting earnings per share of between 6c and 8c GAAP!

What this means is, in the next few quarters, we should see an increase in GAAP mentions and the usual “As a reminder, our commentary today will primarily be in non-GAAP terms.” which precedes every quarterly transcript, will slowly fade like a dying Yoda.

“IT’S A (word) TRAP.” (Buzz-word Bingo)

OK, I admit it. I was struggling with the title on that one.

2017 Q1

2017 Q2

2017 Q3

2017 Q4

2018 Q1

Number of words

1997

2511

2505

3317

3278

Customers/Customer

27

17

20

26

28

Revenue

10

19

18

31

28

Cloud

6

16

12

14

22

Growth

7

9

10

15

16

Operating

8

6

3

18

11

Salesforce/Salesforce’s

20

18

40

crm

15

An insane amount of mentions of Salesforce (double the last couple of transcripts) and we have the usual mentions of Customers, Revenue, and Cloud. The interesting new addition is ‘crm’ with 15 mentions. Salesforce has been trying to shake off the CRM tag for years, given their ever expanding offering, so it is unusual that we have a Return of the Acronym.

There is a decrease in the mention of the word ‘Operating’, usually in the context of ‘Operating Cash Flow’ (where we see a significant part of the business of Salesforce is selling shares to its employees) or ‘Non-GAAP Operating Margin’. This could be part of the transition of moving to GAAP accounting for the transcripts but this will be more evident as time goes on.

Visions of the Future

Last month, as I was late in writing my report, I did not bring my Jedi powers to bare on the fortunes of Salesforce. However, my vision for the next quarter is a revenue of $2.5b and a break even/small loss for the profit. Beyond that, impossible to see, the future is.

Conclusions

Salesforce appear to be at a turning point in their fortunes and signalling this is a new day, a new beginning. If they stay on target, they will start turning a real profit. Unfortunately, I have seen this optimism before. Salesforce need to stop printing money through shares and get their house in order in regards to revenues and costs. They need to stop dealing with the vague and unconvincing Non-GAAP numbers and embrace a different path, otherwise they may choke on their aspirations.

In my experience, there is no such thing as luck and it is your focus that determines your reality. Others may find my lack of faith disturbing and suggest I should let go of my hate because a fear of (financial) loss is a path to the dark side.

I welcome the next episode in this saga and thank you for playing.

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